January 2016
Geoff Blanning, Head of Commodities
After five years of declines, the commodity bear market is long in the tooth and we certainly expect bullish surprises, when they occur, to trigger strong recovery rallies in 2016 and beyond.
Commodity investors suffered in 2015 as major headwinds continued, primarily the strengthening dollar and the weakening Chinese economy. In the energy market, the new Saudi-led OPEC market share policy drove oil prices much lower than many expected, while weather played an unusually important role too, reducing demand for both oil and gas in the US and Europe.
Looking ahead, three key catalysts for bullish surprises can be highlighted:
1. Geopolitics: historically important to commodity investors but now almost completely forgotten. It is a matter of time before disruption to commodity trade flows occurs again – most likely energy or food-related in the Middle East and/or Russia. In the past quarter, Turkey joined the list of countries in dispute with Russia, while pressure on Saudi Arabia’s rulers continues to grow.
2. US dollar: with currencies being difficult to forecast, the confident consensus of further dollar gains seems inappropriate, especially when observing the Federal Reserve’s tortuous interest-rate deliberations. When the dollar turns, commodities could surge.
3. Supply/demand balances: this extended period of declining prices is setting the stage for a return to supply/demand balance across a range of commodities. Distress amongst miners and energy producers accelerated in Q4 and the inevitable adjustment to supply will likely be extended. US natural gas, which has recently been trading below the cost of production, is a prime example.
Energy
Energy looks like the sector with the greatest potential for price appreciation in 2016, although risks remain in the short-term.
The big surprises for the oil market in 2015 came on the supply side: first, production in the US and other non-OPEC nations held up much better than expected; and second - more significantly - OPEC production actually increased, led by Saudi Arabia and Iraq.
With oil priced at US$35/barrel at time of writing, it is more likely than ever that US production will fall steeply in
2016, and commence declines in many other regions too. Further potential gains from OPEC producers – primarily Iran but possibly Libya too – will be insufficient to outweigh non-OPEC declines in the medium-term.
Assuming global demand continues to grow at a modest rate, therefore, it is logical to forecast a solid price recovery as the year progresses.
The problem for oil remains in the short-term. The recent disastrous OPEC meeting, which confirmed a production “free-for-all” (no quotas nor overall target), gives rise to the possibility of higher OPEC output in Q1
2016. The favourable shift in the supply-demand balance that we foresee in 2016 could, therefore, be delayed.

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Thus further downside risk remains in the short-term but an eventual strong recovery towards US$60 (i.e.
+70%) appears inevitable once supply gains have peaked out.
Mild weather killed any chance of a rising US natural gas price in recent months. However, there is a clear shortage of gas developing in the medium-term (1-2 years) – a bullish outlook reinforced by the recent fall in price. We project a severely undersupplied market by the end of 2016, offering gains of 30-40% on a 12-month view. EU gas could also benefit from renewed Russia-Ukraine tensions.
Precious metals
In 2016 gold could benefit from an increase in geopolitical or macroeconomic concerns, or from any weakening of the dollar.
In gold, a key question is whether the market’s focus will shift in 2016 from its recent obsession with US interest rates and the dollar to a focus on demand and supply.
Although this is likely to be delayed, a greater focus on US real rates is probable; recovering inflation will keep real rates suppressed, supporting gold. We also believe the macro risk environment is underestimated. Gold could gain anytime there is increased pressure on major equity indices, stress in high-yield markets or a further ratcheting up of China’s financial crisis.
Platinum fundamentals remain neutral. A very weak rand (moving from 11.5 to over 15 to the dollar in 2015) has delayed supply adjustments in South Africa (70% of global platinum mine supply). Moreover, investor sentiment was seriously impacted by the VW scandal (implies less demand for diesel vehicles) and sizeable
ETF liquidations followed in September/October. The impact of the Volkswagen scandal, however, is likely to be less than initially feared. Nevertheless, the market is carrying high inventories. Evidence of inventory draws and confidence that the market is in deficit ex-investor demand is a pre-requisite for a sustainable price recovery.
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